Rent v. Owning Your Home, opportunity cost and running some numbers

The saga of trying to sell our house in this unfavorable market continues. We have just lowered our price yet again.  If it sells, I have a great degree of confidence we will have sold at the absolute bottom.  We’d be thrilled with that.  To see why, let’s play with some numbers.

Is my bias showing?

Rent v. Own But before we begin, we need clear the air on a few things.  Owning a home is almost always a lousy investment.  Relax. This doesn’t mean you should never own one.

It does mean you ought to be clear on your reasons and not let yourself be suckered into a false reality. It means you might want to run the numbers.

Some people love the sense of ownership and enjoy working on their property.  Neither apply to us, but maybe that’s you.  That’s fine. We can understand.

We’ve owned a couple ourselves over the years. Sometimes for schools and an environment for raising our daughter.  Sometimes just because we liked the house.  But never thinking we were making an investment, let alone a good one.  That’s folly.

Other times we’ve rented and enjoyed the freedom and flexibly that lifestyle offers.  Sometimes we’ve been both landlord and tenant at the same time, arguably the best of both worlds.

Now renting is the direction to which we are ready to return.  But we’ve never made these choices without first considering the costs.  You might want to do the same.  Using our numbers, here’s how….

The apartment we’ve targeted will cost us about $2000 per month, $24,000 per year.*  Built into that are a few extra expenses we’ll pick up not owning.  Winter storage for my motorcycle and summer storage for the car’s snow tires, for example.

Our house is on the market for $355,000 and after commissions and fees we’ll net around $330,000.  (This is lesson #1.  Buying and selling houses is expensive.  Unless you are sure you are ready to settle in for a number of years, rent.  End of story.)  We are mortgage free.

Opportunity Cost

With $330,000 equity tied up in the house the first and largest expense to consider is “opportunity cost.”  That is, simply, what could this money be earning elsewhere?   Right now it is locked up in the house and earning zero interest or dividends.

Here we need to select a proxy.  In your own analysis, you might use whatever you plan to invest in.  Or, if you are renting and considering a purchase, whatever you currently have your soon-to-be tied-up-in-the-house money invested in.

I choose VGSLX, which is the Vanguard REIT Index Fund, because I intend to move the money here  to maintain my asset allocation in real estate once the house is sold.  Since VGSLX pays a dividend of about 3.5% the opportunity cost is $11,555 (330k x 3.5%).  That is, VGSLX would pay me $11,555 per year while the house pays nothing.

Capital Gains

Of course, the house might rise in value providing me with capital gains.  But VGSLX has this same potential.  In actual point of fact, the fund is the more conservative investment.  Here’s why:

VGSLX is a broad based fund holding investments in numerous properties all across the country.  The house is a far more focused holding: one property in one neighborhood in one town in one state. As such it could provide greater or lesser gains.

During 2011 VGSLX rose about 12% while my house value continued to slide.  2012?  Who knows? Maybe the house will outperform.

Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal.  Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.

Running the Numbers

$11,555 opportunity cost. This is the 3.5% dividend our 330k could be earning in VGSLX.

$18,000 in cash expenses comes from these:

  • $2500 heating oil.  Heat is included in the apartment rent.
  • $7000 maintenance & repair & insurance (an average based on our actual records)
  • $8500 real estate taxes

$29,555 total annual cost of owning and operating the home.  Pretty shocking, no?

v. $24,000 rent =

$5,555 annual premium to live in the house.

Now looking closely you’ll notice, while the apartment saves us $5,555 per year, there is an $6,000 cash flow advantage to owning the house.  It takes 24k in cash outlay to rent the apartment but only 18k cash to operate the house.

This is similar to the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) for a business. Cash flow is critical in running a business or your household.  But the ITD&A are all real costs that you need to consider in an accurate fiscal evaluation.  So is opportunity cost.

Overall costs trump cash flow costs, simply because they are more complete.

There you have it, the most fiscally precise way to compare the real money costs.  Just plug in your own numbers.

Running the Numbers another way

But wait, some will say, owning the house saves you $24,000 in rent.  Isn’t that like an investment return?This is a bit clumsier, but sure, we can approach it from this direction.

It looks like this: $24,000 rental savings (investment return) owning the house, minus:

  • $2500 heating oil
  • $7000 maintenance & repair & insurance
  • $8500 taxes

$18,000 total cash expenses =

$6000 positive cash flow in house, minus

$11,555 opportunity cost =

-$5,555 annual investment deficit, i.e. cost of house over renting.

Cash flow cost also remains the same.

What about mortgage interest payments?

If you have a mortgage, and many do, you simply need to add an extra couple of numbers to the formula.  Let’s take a look.

Suppose I had 20% equity ($66,000) in the house and an 80% mortgage of $264,000.

$2310 opportunity cost. This is the 3.5% dividend our 66k could be earning in VGSLX.

$23,795 in cash expenses comes from these:

  • $2500 heating oil.  Heat is included in the apartment rent.
  • $7000 maintenance & repair & insurance
  • $8500 real estate taxes
  • $10,560 estimated interest on our mortgage loan @ 4% (note: the portion of your months payment that is applied to principle should not be included for this purpose although you will want to add to to calculate your cash flow number)
  • -$4765 tax deduction savings.  This assumes a 25% tax bracket and includes the real estate tax and mortgage interest above.

$26,105 total annual cost of owning and operating the home.

v. $24,000 rent =

$2105 annual premium to live in the house.

Because you have a mortgage your cash flow cost is now up to $23,795.

Bottom line.

So, even selling at the market bottom I come out ahead.  I can handle the higher cash flow and that $5,555 in annual savings is real money in my pocket.  Plus I get to step into the blissful renter’s life again.

BTW, while owning your own house is a lousy investment, investing in rental houses can be a whole other and very profitable thing.  As alluded to above, at one time many years ago I was both a renter and a landlord at the same time.

These days investment real estate is too much like work for my tastes.  But there is money to be made if you are willing to make the effort.  Shall we run some numbers?  Sounds good and my pal DD has done a fine job of it here:

http://dollardisciple.com/rental-property-financing-or-please-dont-pay-cash/#comment-312

Post Script:

In the rent v. own analysis there are several formulas that provide some rough guidelines as to which is fiscally better.  Here are two:

1.  House price/Annual rent.

If the result is 21+ renting is better

Between 16-20 it’s a toss-up

less than 16 is a vote to buy

Using our number:  $330,000/$24,000 = 13.75   This says we should buy, or in our case stay put.

2.  Monthly rent x 110 = house price.

If the house costs more, rent.  If less, buy.

$2000 x 110 = $220,000.  This one says no question, rent.

So maybe these are not much help.

More useful, I think, is to look at actual numbers for a given situation as we did above.

 

Addendum I:

Rent v. Own in Ecuador

Addendum II:

The Mad Fientist has a great post on his planned path to wealth.  In it he has a compelling assessment of how renting will help smooth the way:  http://www.madfientist.com/shortest-path-to-financial-independence/

Addendum III:  

Podcast –Why your house is a terrible investment

Addendum IV:

*Turns out I vastly over estimated the cost of our apartment. Rather than $2000/$24,000 per month/year, the number I used in the post scenarios, the actual rent is $1415 per month, $16,980 for the year. Since these numbers are only used as an example to illustrate the concepts, I don’t feel the need to recalculate them in the post. It is the technique that matters and in applying it you’ll want to use your own numbers anyway.

Addendum V: Apples and Oranges

Some have observed that my examples above are not an Apples v. Apples comparison.  Indeed they are not.  But this only becomes an issue if you are looking at it as an academic exercise designed to prove a “winner” in comparing renting v. owning. I don’t.

In my opinion it is far more useful to compare two actual choices someone might be considering, and the framework I’ve provided here is designed to do just that.  I’ve simply used our situation as the example.

You might be currently living in an apartment and considering buying a house. Or, like us, you might own a house and be considering renting again. Running your own number comparison will tell you what each option you are considering will really cost. You can even compare houses at different price points.

People make choices in the real world and running the numbers in the fashion I’ve offered lets them see precisely the financial implications of their choices. If they care to.

Having said that, should you be interested in what the numbers look like if we compare owning v. renting my specific house, check out my February 26, 2012 conversation with Executioner in the comments below.  In my reply I run those exact numbers and you can see the same framework used in a direct apple v. apple comparison, again using our house as the example. It works either way.

The point is not that you should rent. Or that you should own. The point is, it is worth understanding the financial ramifications of your choices. Doing so positions you to make a more informed decision.

Once you have a sound handle on the numbers, you are also in a better position to evaluate the various lifestyle issues, deciding what such things are worth to you.

 

Related Posts Plugin for WordPress, Blogger...
This entry was posted in Homeownership. Bookmark the permalink. Post a comment or leave a trackback: Trackback URL.

80 Comments

  1. Posted February 24, 2012 at 10:44 am | Permalink

    Interesting analysis! I always roll my eyes (hopefully people can’t see me) whenever someone repeats the mantra “Your home is your biggest investment!” No.. investments make me richer! My house is just a place to live. Everyone needs somewhere to live and some people just prefer houses.

    The opportunity cost is an interesting angle and it changes the whole game. That’s actually one reason why we opted NOT to pay off our house and instead buy the rentals. Our mortgage is at 4.75% and our rental portfolio is yielding 24% (albeit, with some input of time on our part). The math was easy :)

    • Quant
      Posted February 12, 2014 at 8:20 am | Permalink

      If you are basing your investing decisions off of an expected 24% annual return… God bless you.

  2. Posted February 24, 2012 at 12:44 pm | Permalink

    I paid off our mortgage a few year back when rates were higher.

    However with rates at these exceptionally low levels, were I making the decision today, I’d keep the mortgage and leave the money invested in VTSAX for the higher long-term gains.

    http://jlcollinsnh.wordpress.com/2011/06/14/what-we-own-and-why-we-own-it/

    For somebody running a real estate investing business like you DD the decision, is as you say, easy.

    Readers, to see DD’s wonderful analysis of leverage in investment RE, hit the link in my post above.

  3. Posted February 24, 2012 at 5:09 pm | Permalink

    Thought provoking post! Loved the analysis tools at the bottom, but I agree…looking at all the numbers realistically is even better. Does the 2k/month include utilities?

    • Posted February 24, 2012 at 5:46 pm | Permalink

      thanks, FF….

      agreed. always best to run your specific number on these things. Hopefully the post provides a framework for it.

      the 2k includes heat, water, sewage but not electric, phone, cable or internet.

      • Posted February 27, 2012 at 3:11 pm | Permalink

        Gotcha. That’s not bad….electric is the baby of all utility bills.

  4. Posted February 25, 2012 at 6:57 pm | Permalink

    Timely post, as I’ve been going through this argument in my mind and on paper (as I do calculations).

    I’ve come to the overwhelming conclusion, that while buying will likely come out ahead monetarily for me if I stay in one place for 10+ years, However, I don’t really like the idea of being chained to a location (and house) for that long. 10 years is a long time in one person’s lifetime, as life is relatively short.

    I like the idea of one day living off my dividend income and perhaps traveling to low cost locales like Ecuador, Thailand, the Philippines and what not. Being tied down to a house in hopes it appreciates and sells so that I can go somewhere is uninteresting at best, and sickening at worst. And, even if I don’t travel and stay in the United States once you’re no longer tied to a specific geographical location through employment…then you’re really free to come and go as you please and that’s a freedom that I’m willing to pay a premium for through renting.

    There’s always the option of renting out a house, but who wants to worry about landlording when you’re off living a wonderfully exciting life somewhere 5,000 miles away?

    I don’t enjoy cutting the grass, painting walls, customizing a living room, landscaping, impressing neighbors, being tied down to one location, being tied down to an object or having most of my net worth tied up in one illiquid asset that is slowly falling apart.

    Great post!

    • Posted February 25, 2012 at 8:23 pm | Permalink

      Hi DM….

      Wonderful comment, and I just read it out loud to my wife. We can relate, and you had us LOL with your last line. Amen!

      As you may know from my other posts we are in the process of trying to sell our house to return to the blissful, carefree, flexible and more profitable life of a renter.

      You’ve absolutely nailed all the downsides to homeownership. The only thing I’d question is your thought that you’d come out ahead with a house after ten years.

      Houses are terrible investments. Unless someone needs a forced savings plan thru lack of discipline. That’s certainly not you.

      I have a post under construction about this, but renting for the fiscally disciplined is always the more profitable choice.

      Your plan of living in various places around the world matches ours exactly. We spent last summer in Ecuador and highly recommend it. Wonderful place. This year we’ll be in Peru and Bolivia. My wife loves her job but working for the schools at least she has the summers off.

      Our daughter was in Thailand a couple of years ago and raves about it. Sounds a bit hot and humid for our tastes, but she had a great time and loved the people.

      As for the Philippines, the son of a pal of mine recently married a Philippine girl. They traveled there to meet her family and he’s been talking about moving there ever since.

      There are a lot of very cool places to visit in the world. Beats the hell out of mowing the grass.

  5. Trish Rempen
    Posted February 26, 2012 at 3:02 pm | Permalink

    I’ve owned a lot of homes, starting with the cottage in Ireland on an acre – that cost me 2000 pounds.(US 4000.) With the romantic stream. (Of course, it had no plumbing, but hey-)
    Bought another farm in Ireland for 5000 pounds (US 10,000.) An acre, 2 storey – and plumbing! Coupla outbuildings and barns…and an acre of bog.
    Then there was the villa in Spain, gorgeous view of the Mediterranean, bought for $28,000. (Furnishings were an extra $3000.)
    These were pretty easy purchases. No mortgages. Few costs.
    Between now and then, I’ve sold or bought (I think) 18 properties. Still own 5 of them. Maybe 6.
    Still no mortgages.

    And yet – after all that – I agree with your post! With few exceptions, buying a house, unless you like houses and don’t need a mortgage – is a responsibility. I just understood real estate better than I understood funds. I never did the homework – or had your blog to read! If I had, I might not have bought the houses! (And yes, I do have the VTSAX now—)

    PS: Yes, the villa in Spain is sold. Sorry.

    • Posted February 26, 2012 at 8:42 pm | Permalink

      As I recall, you’ve owned several rental houses and those can be very sound investments. Do you still have them?

      In some places around the world the numbers plugged into the formula could look very different.

      When we were in Cuenca, Ecuador last year we looked at some apartments. You can buy a beautiful 2-bed/2-bath place for 125K or rent one for $800 per month:

      $4375 opportunity cost. This is the 3.5% dividend our 125k could be earning in VGSLX.

      $1700 in cash expenses comes from these:

      n/a heating oil.
      $1200 condo fee for maintenance; repair; insurance; security
      $500 real estate taxes

      $6075 total annual cost of owning and operating the home.

      v. $9600 rent =

      $3525 annual premium to rent. So here buying makes more sense. I’ll bet the number on your places in Ireland and Spain would have equally favored buying.

      • Trish Rempen
        Posted February 26, 2012 at 11:13 pm | Permalink

        Still have 3 rentals here in NM. But I wouldn’t have done it if there had been a mortgage involved. And yes, you’re right on the European ones…
        Of course, if you want to put in plumbing, it’s best to own the place.
        And the absence of plumbing didn’t deter the previous owners from raising 14 children in the house. We had different priorities.

        • Posted February 26, 2012 at 11:32 pm | Permalink

          how have they been as investments?

          and where are your other two houses?

          • Trish Rempen
            Posted February 26, 2012 at 11:42 pm | Permalink

            Overall, good. I like the places, would live in any of them myself. I use an agency, so I don’t deal with too many of the issues, and I bought them all at a good price.
            The other houses? I live in one, and the other is a cabin in the Jemez mountains!

      • Posted March 22, 2012 at 8:34 pm | Permalink

        an additional thought on this. In running these numbers you should demand buying be less expensive than renting to compensate for the additional risks of ownership.

  6. Posted February 26, 2012 at 3:56 pm | Permalink

    Greetings from another NH resident.

    Just playing devil’s advocate here…how would the numbers look if you had done this comparison using the rental price for your house, instead of an apartment? How much would you charge someone to rent your current home from you?

    I wonder if running this comparison between a $330K home and an apartment might not be exactly apples-to-apples.

    It sounds to me like you’re gaining some of the “renting advantage” simply by downsizing. Couldn’t you gain a similar advantage by selling your large house and buying a smaller condo? I think you’d see extra cash flow in that scenario too, without bringing rent into the equation.

    • Posted February 26, 2012 at 8:49 pm | Permalink

      Hi Ex, and welcome.

      You make an excellent point and, in fact, we can look at this with some precision. A few months back someone looked at the house and made an offer to rent it @ $2500 per month, 30k annual. This seems a fair rate and it does make your point that some of the benefit we’ll realize is from downsizing. Here are the numbers:

      $11,555 opportunity cost. This is the 3.5% dividend our 330k could be earning in VGSLX.

      $18,000 in cash expenses comes from these:

      $2500 heating oil. Heat is included in the apartment rent.
      $7000 maintenance & repair & insurance (an average based on our actual records)
      $8500 real estate taxes
      $29,555 total annual cost of owning and operating the home.

      v. $30,000 rent +
      $2500 heating oil. (In renting the house tenants would pay for heat) =

      $32,500 to rent the house
      - $29,555 to own it

      $2,945 annual premium to rent.

      Of course, we can also change other numbers too. For instance, we could invest our 330k in RAI which pays a 5.5% dividend. The numbers then:

      $18,150 opportunity cost. This is the 5.5% dividend our 330k could be earning in RAI.

      $18,000 in cash expenses comes from these:

      $2500 heating oil. Heat is included in the apartment rent.
      $7000 maintenance & repair & insurance (an average based on our actual records)
      $8500 real estate taxes

      $36,150 total annual cost of owning and operating the home.

      v. $24,000 rent =

      $12,150 annual premium to live in the house.

      What I’ve tried to do with this post is to provide a framework for others considering the rent/buy issue. What makes most sense is to plug in the actual numbers for a specific situation and see what comes up. I just used ours as an example. Make sense?

      BTW, congrats on “executing” your mortgage last year. Great feeling, that! Where in NH are you?

      • Steve
        Posted September 19, 2013 at 11:42 am | Permalink

        I’m a newcomer to your blog coming over from MMM. I’m really enjoying it! As an engineer I always appreciate a numerical approach to finances and feel that you do a great job of taking a numerical approach to your financial advice.

        While I agree that in your position and example here, you will be making a great move (or maybe already made? I’m over a year later here…), I had a different take on this “apples to apples” comparison you just made.

        Using the expenses you mentioned before, the cost of renting your house were stated as $32,500. 3.5% in the VGSLX would make your cost of owning and living in the house $29,555. In this case owning the home is $2945 cheaper than renting.

        In the second scenario with an opportunity interest rate of 5.5%, the cost of owning increases to $36,150, but you then compared it back to the less expensive apartment (at $24k). The “apples to apples” comparison says that it’s only $3,650 more expensive, not $12.5k.

        I’m closer to the beginning of my career and have many years to save. My family is also still in the growing phase, so I’m looking for houses that are about the same size as the one we are renting; hence my interest in this apples to apples comparison, since we don’t want to downsize from the house we are currently renting. If we were renting your house, it would cost us $32,500. If we then bought your house we would be paying $18k to live in it, and freeing up the $14.5k difference would have cost us $330k. That’s an effective rate of about 4.4%.

        That’s not a bad rate, and it would be a guaranteed return, but I have many years until retirement and am expecting to get a better average return from my Vanguard index fund than that. Add in the costs of buying and selling a home and renting becomes more and more attractive.

        The take home is that it is different for everyone, and running the numbers, in addition to other “real-life” factors that are not necessarily financial, is definitely the right thing to do. In the end, everyone should just be aware of how much their choices and lifestyle are costing them, and then they can choose however they want!

        • jlcollinsnh
          Posted September 20, 2013 at 12:01 pm | Permalink

          Hi Steve….

          Welcome! Glad you found your way over here.

          First, good catch! You are absolutely correct in saying:

          “Using the expenses you mentioned before, the cost of renting your house were stated as $32,500. 3.5% in the VGSLX would make your cost of owning and living in the house $29,555. In this case owning the home is $2945 cheaper than renting.” I’ve now corrected that in my reply to Executioner. Thanks!

          As for the second scenario, you can certainly look at it in a the more apples-to-apples comparison. And given your personal situation, that makes perfect sense.

          But I’m more a believer in comparing apples-to-oranges as that better reflects the decisions we make in the real world.

          (for more see my conversation with SC below)

          For instance, as it turned out, my apartment only costs me $1415 a month rather than the $2000 I had budgeted.

          Of course you are right that buying and owning a home is not just a financial decision. That’s why I owned houses for 28 years. For more along those lines you might enjoy:

          http://jlcollinsnh.com/2013/03/20/roots-v-wings-considering-home-ownership/

          Good luck with your own choices! Please keep us posted.

  7. Posted February 27, 2012 at 8:22 am | Permalink

    I have seen the argument against home ownership from an investment standpoint before, and while I tend to agree, there is one thing I don’t understand.

    First of all, it can’t be a losing proposition to own, because if it was then you wouldn’t be able to rent. Because nobody would bother owning properties and renting them out.

    Now, you may say “well, rental properties are a different story”

    OK, But if you buy a house, what are you doing if not just renting to yourself? The best, most reliable tenant you could get?

    For example, Lets say you took the $330,000 from the sale of your house and instead of the REIT you bought a rental property. Most people would say that is a good investment (as long as the particulars of that house were sound).

    But what is the point of owning a house, renting it to somebody else , and renting ANOTHER house, from somebody else, for yourself?

    How would your calculations change if you counted yourself as a tenant, and ran the numbers for home ownership that way?

    • Posted February 27, 2012 at 12:33 pm | Permalink

      Hi Mr. Monk…

      great to see you over here and thanks for commenting. great questions!

      It is possible to think of your house as an investment and yourself as the tenant. That is a bit what we do by approaching it with my second set of numbers above titled:

      “Running the Numbers another way”

      Or you could take a look at the numbers in my response to Executioner below for another take.

      Owning rental properties becomes an entirely different thing because of the actual income received and the tax deductions.

      Let’s say I view myself as a tenant in the home I own and even pay rent to myself into a separate account. From this account I then pay the operating expenses. That’s fine as far as it goes. But the IRS isn’t going to want to hear it come tax time.

      If instead, I rent to you all of those expenses are now deductible and I can also take a depreciation deduction as well. Then you buy the same house across the street and rent to me. You can do the same.

      Another issue is the type of house. Our home, in mint condition and at it’s price level, doesn’t offer an investor the same opportunities as a more modest home in need of some repair. You can see this very clearly in Dollar Disciple’s post (see link above)

      If not for these two factors, you are absolutely correct. Personal or rental, the investment evaluation would be the same. But these are pretty big factors.

      Hope this helps?

  8. Posted February 27, 2012 at 6:00 pm | Permalink

    Good article. There are lots of different ways of looking at this.

    From your description, you are going from a house to an apt. Renting will usually be cheaper because the equivalent housing value is lower. Where I live, the average home goes for 750K. The apt I have looks like a bargain in comparison when you compare monthly outlays, but if the apt could be priced at market it will would be much less than half the average home. So, renting beats owning because you are “buying” less property.

    In many parts of the country, owning is cheaper when comparing it by market value. I wonder if you could rent your same house, would it still be cheaper?

    • Trish Rempen
      Posted February 27, 2012 at 6:51 pm | Permalink

      To “6-Figure Investor”:
      That’s an aspect of buying or owning that so few people consider: Maybe you really don’t NEED the 3 car garage, the extra media room, the fitness room or the 5th bedroom…!
      When I buy a house as a rental, I always make it a small one – there will always be a market for a small (and hopefully cute) stand-alone house in an area around hospitals and universities.
      Big simply costs more. If you buy it – or rent it – make sure you need it. There’s always a cost involved.

      • Posted February 27, 2012 at 9:36 pm | Permalink

        excellent and important point. This is why we are looking to downsize into a smaller space.

        We are looking to rent because the money will be more productively invested outside a house.

        I’ve noticed most successful RE investors buying houses follow Trish’s path. I would.

    • Posted February 27, 2012 at 9:33 pm | Permalink

      Hi SFI….

      Nice to see you here.

      Executioner asked very similar questions in his comment below. You might want to check out my response and analisis there.

      thanks!

  9. Posted March 1, 2012 at 6:23 pm | Permalink

    Good thinking. My wife and I are also thinking about downsizing as my daughters have gone to college. We have a huge house(over 9000 sq feet), which we don’t need for two of us. I’d rather invest my money wisely than to pay mortgage.

    • Posted March 1, 2012 at 11:41 pm | Permalink

      Thanks Shilpan…..

      That’s a lot of house for empty nesters. good luck when you decide to sell. moving ours is turning out to be far more of a challenge than I’d have ever guessed.

  10. Posted March 11, 2012 at 2:38 pm | Permalink

    Just popping over to say hi; you already know that I think that the more expensive your house is the more sense it makes to rent and invest the equity.

    • Posted March 11, 2012 at 6:24 pm | Permalink

      Hi Maria….

      and welcome. True dat. Now I just need to get it sold, no easy task that. ;)

  11. Posted March 26, 2012 at 11:05 am | Permalink

    Hi JLC – found you from MMM and really appreciate this post. I had never questioned the economics of owning vs. renting, I guess just because of that pervasive ‘American Dream’ attitude. I will be much more conscious of the tradeoffs and definitely run the numbers when my time comes, so thanks for opening my eyes!

    • Posted March 26, 2012 at 12:25 pm | Permalink

      Hi Arya….

      and welcome! Thanks for the very kind words and glad to hear you found value in the post.

      Hope you’ll stick around, read some more and keep commenting.

      Cheers,

      JC

  12. Posted May 28, 2012 at 5:21 am | Permalink

    Love those final metrics. I made my way over here from MMM’s wonderful site, and am slowly reading all your back articles. Currently renting in Japan, and doing the math our target house price divided by current and (forseeable future) rent is over 100!!!

    Guess we’re staying renters despite the wife’s nesting insticts :)

    • Posted May 28, 2012 at 2:24 pm | Permalink

      Welcome Sendaiben….

      glad you found your way over here and thanks for the comments.

      Over 100??!! yikes. suppress those nesting instincts!! ;)

  13. Posted August 28, 2012 at 9:42 pm | Permalink

    Per your request, I am re-posting this comment from another location.

    I submit that there are some intangible benefits to owning that will never show up on a rent/own comparison analysis. These have to do with stability and flexibility.

    Stability:
    - Rent can increase
    - Landlord/Property Manager can go bankrupt, die, decide not to renew the rent, decide to sell, forcing you to move

    Flexibility:
    If you are a renter, it is much more difficult (if not impossible) to do the following:
    - Cultivate and harvest natural resources from your land (timber, crops, livestock, etc)
    - Add-on or remodel at will (add a garage, plant a tree, repaint the interior, add energy-saving improvements, build a shed, destroy a shed, knock down a wall, add a window, remove a door, build a moat and drawbridge, and so on)

    I also re-iterate the point that I’ve made on many blogs in the past (including yours I believe) that if you rent, you are indirectly paying the landlord’s taxes, insurance, and fees. Those costs are unavoidable. The only thing you can avoid as a renter is maintenance costs in the short term, although in the long run you’ll probably end up subsidizing them through your rent payments too.

    Finally, if you value privacy and elbow room, it’s a lot more difficult to find a rental property without neighbors on all sides (often sharing walls or floor/ceiling).

    I’m not saying it doesn’t make sense to rent. However I don’t think it is quite so straightforward as running a financial analysis and going with the cheaper result.

    • Posted August 28, 2012 at 10:25 pm | Permalink

      Thanks E…

      much appreciated!

      Regarding your comments, we are mostly on the same page. There are many non-finacial reasons to buy a house, and to rent. Depends on individual needs and preferences.

      My main point is that running the numbers provides an objective measure of what the comparative cost will be. since most people don’t bother they are unaware of the real cost of their house purchase and rely on the propaganda of the real estate industry.

      Having run the numbers I KNOW my house costs me $5-6000 dollars more each year than the equivalent apartment. Raising my daughter, especially in this school district, made that extra expense worthwhile. Now, not so much.

      Oh, and RE taxes, repairs and maintenance can and do rise very bit as quickly as rent.

      When you get your moat and drawbridge finished, let me know. I’d love to take a ride up to see them! ;)

  14. Posted January 3, 2013 at 10:42 am | Permalink

    We are currently renting. But since we live in Texas renting is actually more expensive than a mortgage. We are currently saving for a 20% down payment. Want to buy a small 3 bedroom/2 bath home. In Dallas, TX they range from $130k to $150k. Our goal is to put down 30K.
    I’m still not sure whether we should choose a 15 yr or 30 yr mortgage. We could afford a 15 year mortgage, since that and taxes will equal what we pay in rent. But a lot of people (adults who are more financially stable than us) have told us to get a 30yr mortgage, and invest the rest of the money.
    What’s your opinion?

    • Posted January 4, 2013 at 5:06 pm | Permalink

      Hi SFL….

      Welcome back!

      Congrats on running the numbers and your decision to buy.

      Ordinarily, I’d say go with the 15 year and get it done ASAP. But these are not ordinary times. These are times of extraordinarily low mortgage rates.

      If you are absolutely certain you have the discipline to invest the difference and leave it invested for the long term, go with the 30 year mortgage. You can always accelerate your payments and turn it into a 15 year or less if you choose.

      But if you have any doubt at all about relentlessly investing the difference, stick with the 15 year.

      If you would, please let us know what you find and how the deal comes together!

      Good luck!

      • Posted January 4, 2013 at 5:59 pm | Permalink

        We are not going to be buying until late 2013. According to my time table, this is when we will have saved our 20% down payment, and have enough of other savings to feel comfortable to purchase our home. Plus that’s when our lease ends.
        I am pretty disciplined when it comes to investing and I’m positive we will invest the difference. I will let you know what comes of it when we get close to the home buying deadline! Thanks for your advice!

  15. Prob8
    Posted January 25, 2013 at 11:30 pm | Permalink

    I’ve also found that during my tenure as a homeowner, I always have a desire to “improve” the house. A new fence here, a back up sump pump there, etc. Those costs don’t neatly fit into the maintenance and repair category and I doubt I’ll get my money back upon sale. They also add up over time. During my rental years, I never had a desire to spend a dime fixing up my landlord’s place. I also never had to take time away from more desirable pursuits to mow the grass or call multiple contractors to get bids to fix a problem with the house. In retrospect, my wife and I always seemed happier while renting. Perhaps I’ll return to that lifestyle one day.

    • Posted January 26, 2013 at 12:00 am | Permalink

      That’s a great point, Prob8….

      ….and I do the same with my house. If you have a nice house in a nice neighborhood, it is like a trap. Not only for its own sake, but for future resale value.

  16. Posted March 28, 2013 at 5:14 pm | Permalink

    Great post, I just found this after writing our own take on Rent vs Own for the Seattle area. The tax deduction from mortgage interest may work out to be less advantageous than presented, since a married couple filing jointly has the option of taking the standard deduction; $11,900 in 2012.

    This would make the mortgage interest deduction only a $2,930 reduction in taxes instead of $5,900, although it depends on what other itemizable deductions you may have (state income tax or sales tax, donations, income tax prep fees, etc…)

    We estimated owning was at least a $1,000 a month increase! Like Dividend Mantra above, we didn’t want a piece of real estate tying us down when we started traveling permanently. 6 months in, so far so good!

    Other advantages, in the apartment we paid $0 annually for maintenance, didn’t need to own a ladder or a lawn mower, and our weekends were completely free of maintenance duty. Paying $1,000 extra a month to live in more space than we need, comes with uncertain maintenance and repair responsibilities, is further away from the places we buy groceries and hang out with friends, and places obligations on more of our free time seemed to be a poor trade

    Perhaps I missed it elsewhere, were you able to sell this house?

    • jlcollinsnh
      Posted March 28, 2013 at 6:08 pm | Permalink

      Thanks Jeremy…

      and an outstanding point about the tax write off so widely touted. The truth is, the standard deduction is very generous. At $11,900 it takes a pretty big mortgage/RE tax bill to go over it. And even then the only advantage is the excess.

      So, if your house gives you itemized deductions of say, 14,900, the home ownership tax deduction advantage isn’t 14,900. It is the difference between the two: $3000.

      Even at the 25% tax bracket, and as a married couple you’ve got to be over about 90k in AGI to get there, your tax savings in $750. I spent more than that on snow plowing this year. And that’s not deductible!

      Yep, sold! We move April 3 and close on the 8th. More about that to come.

      • Posted March 29, 2013 at 5:20 pm | Permalink

        Your point about needing $90k of AGI to take advantage of the mortgage interest deduction is an interesting one. With a national median income of about half that, a couple would need to be in the top 20% in order to get any benefit.

        • Jim
          Posted October 29, 2013 at 11:49 am | Permalink

          It’s not quite as gloomy as he makes it out to be. Let’s take a couple making $50k and living in one of the 41 states that imposes income tax. They’ll be in the 15% bracket, but also paying (say) 5% in state taxes. Using that 14,900 number for RE tax+mortgage interest (which puts their house somewhere in the ~$200-$250k range I believe), and adding the $2.5k state tax, we get $825 of benefit…more than his $90k couple in a no-tax (and no sales tax, apparently) state.

          It’s an academic exercise, though. If you’re buying a house just to be able to itemize your deductions, you’re doing it wrong. I bought my house because (1)My PITI is half as much as it would cost to rent an equivalent house, (2)It was appraised significantly higher than the purchase price, and (3)I genuinely like working on it and upgrading it to my standards, which I could never do in a rental. Heck, even when I was renting I would usually be the one fixing stuff instead of calling the landlord, so there have been very few downsides and lots of upsides in my case.

  17. Max Schneider
    Posted June 13, 2013 at 7:57 am | Permalink

    I noticed that many people buy a lot more house than they really need (or previously rent) just to cover all the future possibilities (junior will drive his own car one day so let’s get the three car garage just in case even though we currently only have a single automobile) and then put a lot more stuff (which tends to be a lot nicer and therefore a lot more expensive) inside just because they can and then eventually stretch themselves thin and pay much more than they would if they rented.

    Then on the other hand, if you rented all this cash lying around (because it does’t go into a mortgage) might lead to silly purchases of silly consumer goods, therefore the “opportunity cost” of having the cash tied up in a house instead of hard cold cash might not be as great as one thinks it woud be…

    • jlcollinsnh
      Posted June 13, 2013 at 10:30 am | Permalink

      Welcome Max.

      You are right of course. People can be stupid with their money in both directions, and frequently are.

      But based on the comments around here, the readers of this blog are more thoughtful regarding financial decisions.

  18. serious coinage
    Posted June 13, 2013 at 1:43 pm | Permalink

    You have to make sure you are comparing apples to apples and not apples and oranges. I think Executioner pointed out one error. Is the apartment rental for $2,000 a month really equivalent to your home in terms of size, neighborhood, condition, etc? I suspect your house would rent for more than $2,000 a month- so the costs are probably about the same.

    Another advantage to owning is that you can change the property anyway you like. You can paint, remodel, etc. You can’t do that with a rental.

    For me, it is a no-brainer to own. My house is worth about what yours is, but my taxes are only 2800. I think you said yours were 8500? Ouch. We have natural gas and last year it was about 600 bucks. Home prices in my area are appreciating, interest rates are very low, and I plan to stay put for 10-20 years or more. Why would I want to pay someone else’s mortgage when I can pay my own and build wealth? I understand the opportunity cost of the equity, but the implied rental value I’m getting, plus appreciation, plus tax deductions, far outweigh the opportunity cost of that money in my situation.

    • jlcollinsnh
      Posted June 13, 2013 at 2:24 pm | Permalink

      Welcome SC…

      Here’s my perspective.

      1. Apples v. Oranges only becomes an issue if you are looking at this as an academic exercise. I don’t. The framework I’ve provided here is designed to compare two actual choices someone might be looking at and I used our situation as the example.

      Having said that, if you read my response to Executioner you can see the same framework used in an apple v. apple comparison, again using our house as the example. It works either way.

      People make choices in the real world and running the numbers in the fashion I’ve offered lets them see precisely the financial implications of their choices. If they care to.
      BTW, as it happened our rental cost turned out to be only $1415 per month. $2000 was my best estimate at the time, so that’s what I used.

      2. Theoretically you can change your property any way you chose. But the reality is that if you stray too far from accepted norms your property values will take a major hit. Moreover, those norms change frequently. The tasteful stainless steel appliances and granite countertops you install today might fall from favor and cost you money tomorrow. Almost any real estate professional will caution that remodeling to increase value is tricky and requires very careful planning. Even done well, the payback rarely reaches 100% of the cost. But this only matters if you are concerned about the financial aspects of owning. If not, sure. Do whatever you like.

      3. If you’ve run the numbers and you are comfortable with what they tell you, enjoy your home!

      In fact, I’d say the same even to those who haven’t run the numbers and don’t care to. And to those who have and don’t care what they say. I’m not the least bit interested in persuading anybody about anything here.

      • serious coinage
        Posted June 13, 2013 at 4:24 pm | Permalink

        Thanks for responding.

        Great blog, by the way. I’ve enjoyed reading it. I hope you are right about index funds. I also hope I can keep the discipline to stick with them for the long run.

        Thanks again.

        • jlcollinsnh
          Posted June 13, 2013 at 10:44 pm | Permalink

          Thanks SC. Good to hear.

          As for index funds, what I can promise you is that they and the rest of the market will be hit by crashes and bear markets multiple times over the decades to come. Your resolve will be tested. Guaranteed.

          Those will be the times that determine who makes money and who doesn’t. Warren Buffett won’t be panicking and running for the exits. I won’t be either. (I made that mistake in ’87) My fondest hope is that the readers of this blog, knowing full well such events are to be expected, won’t either. They’ll stay the course and be richly rewarded. Including you.

          Good luck!

    • Aleks
      Posted July 11, 2013 at 3:26 pm | Permalink

      Is the apartment rental for $2,000 a month really equivalent to your home in terms of size, neighborhood, condition, etc? I suspect your house would rent for more than $2,000 a month- so the costs are probably about the same.

      It’s important to separate the “investment” part of owning a property, and the “expense” part of living in a home.

      Everyone has housing expenses. Everyone pays rent. If you own a home, then you’re paying rent to yourself.

      Let’s say that you’re right, and Jim’s house would actually rent for more. For the sake of argument, let’s say it would rent for $2,500. Well, then, by moving to the new apartment, Jim has reduced his housing expenses by $500 per month, or $6,000 per year.

      By selling the property, Jim has reduced his gross rental income by $30,000 per year. But he’s also reduced his expenses by $18,000 per year. That’s $12,000, which coincidentally is about the same amount of money that Jim could earn from investing in VGSLX. And there are extra expenses in owning a property that someone else lives in.

      So even at a $2,500 estimate, Jim comes out ahead in two ways. He reduces his housing expenses by $500 per month, and he moves his equity into an investment which is more liquid and has higher returns.

      Now, if Jim’s house could fetch $3,000 per month, then you start to get into the territory where it would make sense for him to keep the property as an investment. But at that estimate, the case for renting becomes even more obvious; Jim’s new apartment will save him $1,000 per month in housing costs!

  19. Posted June 17, 2013 at 3:52 am | Permalink

    Good advice – I will think twice now about leaving a job where the housing and utilities are provided in order to go build a house. I also appreciated the calculator you included showing percentage of savings to years it will take to retire. This has made me seriously re-think my current situation…

    • jlcollinsnh
      Posted June 17, 2013 at 9:51 pm | Permalink

      Glad you found it useful, Tom.

      Do you own a house now?

  20. Blake
    Posted September 12, 2013 at 4:30 pm | Permalink

    I’ve been poring over these numbers since hearing your analysis. One question though, wouldn’t the equity in your home rise with inflation? This would give you an approximate 3% gain annually, and so your true opportunity cost would only be the 3.5% from your dividends minus 3% inflation of your home price for a total of 0.5%. I did some net present value calculations to compare 30 years of owning vs. renting. Being able to sell the “asset” in year 30 makes the extra on-going costs of buying moot. Although you then have to find another place to live, so maybe the calculations are different for a perpetuity.

    Any thoughts?

    Blake

    • jlcollinsnh
      Posted September 20, 2013 at 11:34 am | Permalink

      Hi Blake…

      Certainly a house could rise in value over time, as could the proxy. I discuss this in the post above:

      “Of course, the house might rise in value providing me with capital gains. But VGSLX has this same potential. In actual point of fact, the fund is the more conservative investment. Here’s why:

      VGSLX is a broad based fund holding investments in numerous properties all across the country. The house is a far more focused holding: one property in one neighborhood in one town in one state. As such it could provide greater or lesser gains.

      During 2011 VGSLX rose about 12% while my house value continued to slide. 2012? Who knows? Maybe the house will outperform.

      Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal. Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.”

      Make sense?

  21. Shashi
    Posted November 26, 2013 at 9:17 pm | Permalink

    Most of you might have already seen this, but still wanted to share the link to NY Times rent vs. buy calculator –
    http://www.nytimes.com/interactive/business/buy-rent-calculator.html?_r=0

    I like the presentation of the analysis and find it very useful.

  22. Brian
    Posted January 20, 2014 at 9:02 pm | Permalink

    What about factoring in income taxes. Some numbers I’m getting are:

    Let’s say you have a 33% tax rate and are renting a similar home (not apartment).

    $0 heating oil will be the same for both homes
    $7000 maintenance & repair & insurance (seems high to me for a $350k house, but we’ll go with it)
    $5,695 instead $8500 on real estate taxes – Assuming you itemize deductions
    $12,695 total cash expenses =

    (Comparable house is $30k to rent, not $24k for an apartment as mentioned)
    $17,305 positive cash flow in house, minus

    $7,626 instead of $11,555 factoring in taxes on the dividends =

    $9,679 annual investment surplus, i.e. cost of house over renting.

    (note that this doesn’t include capital gain taxes that you would owe on VGSLX either)

    • jlcollinsnh
      Posted January 20, 2014 at 11:13 pm | Permalink

      Hi Brian…

      and welcome!

      When you own a home two things are tax deductible from your federal income tax:

      1. Your real estate taxes.
      2. Your mortgage interest and points, if any.

      The industry loves to make a big deal about this.

      But the first thing you want to take note of is that the government allows everybody a Standard Deduction. For 2013 it is $12,200 for married filing jointly and $6100 for singles.

      So looking at my personal example of no mortgage, even living in a state with an exceptionally high RE tax of $8500, I am no where near itemizing. So owning provides -0- tax advantages.

      That’s how I handled it in the post’s first scenario.

      However, in the second scenario we assumed a mortgage and did in fact include the tax deduction:

      $8500 real estate taxes
      $15,120 estimated interest on our mortgage loan @ 4% (note: the portion of your months payment that is applied to principle should not be included for this purpose although you will want to add to to calculate your cash flow number)
      -$5905 tax deduction savings. This assumes a 25% tax bracket and includes the real estate tax and mortgage interest above.

      Of course, given the standard deduction I have overstated the tax advantage benefiting the homeownership numbers. More accurately:

      $8500 real estate taxes
      $15,120 estimated interest on our mortgage
      $23,620 deductible expenses
      -$12,200 standard deduction
      $11,420 in deductions over standard.
      x 33% bracket*
      =$3769 tax savings.

      That’s a even less than the $5905 tax deduction savings I originally calculated at only the 25% bracket. BTW, the 25% bracket is good up to $$223,050 (married filing jointly) in adjusted gross income. Single is 25% up to $183,250.

      *Hitting the 33% bracket is very high income indeed.

      Since I hold VGSLX in an IRA, capital gains taxes are a non-issue.

  23. Iain
    Posted January 23, 2014 at 1:20 pm | Permalink

    It looks like your last calculation neglects the leveraging effects of a mortgage. With 20% down, if your house appreciates by 3%, your equity goes up by 15%. With your numbers, that 3% would be around $10,000. Even supposing that the investment you are missing out on had the same 3% gain, that is only on the 66k – about $2,000. So, on a 3% rise, your calculation misses $8,000 on the plus side for buying – enough to flip the verdict. Of course, leverage increases risks on the downside, too. Prices may or may not return to their historical upward trajectory. But it is clear that the rent/buy decision is far more significantly affected by expected house price movements than your calculation suggests.

    • jlcollinsnh
      Posted January 23, 2014 at 1:54 pm | Permalink

      Hi Iain…

      and welcome.

      I think you may have missed the “Capital Gains” section in the post? In part it reads:

      “During 2011 VGSLX rose about 12% while my house value continued to slide. 2012? Who knows? Maybe the house will outperform.

      “Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal. Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.”

      As you observe, leverage is a two edge sword. Failing to understand this is one of the things that brought so many to grief when the housing bubble collapsed.

      That said, if you have reason to believe the price of a house you are considering will go up (or down) in value, you can certainly factor that into your calculations.

      Just be sure you are basing your assumption of appreciation on some tangible factors rather than wishful thinking. As a point of reference the historical appreciation of houses is ~1%.

      Good luck!

  24. Posted January 25, 2014 at 11:12 am | Permalink

    Hi Jim, love this analysis(and your site). One question – should you be comparing your $330K home to a small apartment? Wouldnt it be more “apples to apples” in comparing a similar townhouse/condo to the apartment? One could argue that you have more space and features in the house than the apartment(as well as the added expenses).

    In our case, we have children and pets. We were renting a similar detached home. As the rent was $2500 it turns out to be much less expensive for us in owning a similar home(around $300K). In our case, the utilities are equal in both options. However, if we were sans children and dogs and planned to travel many months of the year, I would certainly opt for a cheaper alternative.

    There was also the feeling we had in the rental. A sort of uneasiness that the manager could up our rent or evict us at his choosing.

    Thanks again for the great articles!

    • jlcollinsnh
      Posted January 25, 2014 at 6:50 pm | Permalink

      Hi JayP…

      Welcome, and glad you like it!

      Apples v. Oranges only becomes an issue if you are looking at this as an academic exercise. I don’t. The framework I’ve provided here is designed to compare two actual choices someone might be looking at, and I used our situation as the example.

      Having said that, if you read my response to Executioner above you can see the same framework used in an apple v. apple comparison, again using our house as the example. It works either way.

      People make choices in the real world and running the numbers in the fashion I’ve offered lets them see precisely the financial implications of their choices. If they care to.

      Once you have a sound handle on the numbers you are in a better position to evaluate the lifestyle issues, deciding what such things are worth to you.

      Sounds like you’ve not only run the numbers, but lived both options as well. :)

      If owning the house is both less expensive and better for your needs, well done!

      • Posted January 26, 2014 at 1:16 pm | Permalink

        Very true. I hope it works out best to our financial advantage. One house did, one didn’t so far!

  25. Simon Kenton
    Posted January 26, 2014 at 5:38 am | Permalink

    I had posted the comment below under the 4% post http://jlcollinsnh.com/2013/11/12/case-study-4-using-the-4-rule-and-asset-allocations/ but Mr. Collins suggested would be more relevant here:

    I think you are better off – safer – if you treat the house as a house, not an ATM or a savings account or an investment. Basic rule: If you are not willing and able to sell an asset in 5 days (settlement period) you don’t own it. Move it into the net worth column of your kids. This is true for a lot of hard assets (which are peculiarly soft, financially speaking) like guns, jewels, collectibles, as well as houses. The other point about hard assets that needs to be hammered home is that they are a rich field for self-delusion. They are so illiquid that you think they are worth what a neighbor said at a cocktail party; or a half-remembered Sunday Supplement article may have said if your memory serves; or what you paid for them; or “goodwill;” or “great growth prospects;” or what the county assessor has hoked up as a ‘valuation’ in order to increase your taxes. Never value any of them at more than your cost; and you’ll be better off to set them at zero (“$0.00″) in your annual financial retrospective and your future projections. Review Graham – an investment is an operation that upon mathematical analysis promises safety of principal and regular paid returns. A house doesn’t make it unless you are renting part of it out. Pay it off ASAP with heavy infusions of cash flow (NOT principal) from other real investments while the loan is young and either 1) drop it out of the net worth if you are going to live in it, or 2) make it a rental while moving to a smaller place. If you transmute it to a rental you may restore it to the net worth column.

    This advice is sound partly because if you follow it, the surprises you get when you sell out of a particular hard asset will be positive, or at least non-negative.

    • Kurt Knapp
      Posted February 20, 2014 at 10:06 am | Permalink

      “Pay it off ASAP with heavy infusions of cash flow (NOT principal) from other real investments while the loan is young”

      You favor paying off your home with the returns of your other investments versus re-investing those returns?

      If the house is draining say 3.375% (my mortgage rate) and stocks “return” say 7%, wouldn’t it be wise to “net the difference” by paying the minimum monthly mortgage payment? Paying it off early locks in a 3.375% return where taking cash flows that would be used to pay it off early and invest in the market would produce a 7% return.

      Perhaps this is a “make the best of it scenario” meaning one shouldn’t buy a house in some instances. But if you do, and lock in a low rate, shouldn’t one “make the best of it” and ride out the “cheap money”?

      In other words, I’m sure banks would prefer that I pay off my 3.375% loan so they can loan it out at today’s rising rates, for the same reason I should want to “hold onto it”, now that I already have it.

  26. MDM
    Posted March 4, 2014 at 12:14 am | Permalink

    Just an observation regarding the Post Script. To recap briefly the two methods are
    1. If House price/Annual rent is 21+ renting is better, 16-21 it’s a toss-up, less than 16 is a vote to buy
    2. Monthly rent x 110 = house price. If the house costs more, rent. If less, buy.

    But we can plug #2 into #1 and get
    (Monthly rent x 110) / (Monthly rent x 12) = 110/12 = 9.2

    So #1 says a ratio < 16 means buy, while #2 says the ratio has to be < 9.2.

    No idea which, if either, is "correct", but they are certainly different.

    • Brovan
      Posted March 7, 2014 at 11:52 pm | Permalink

      MDM, we were thoroughly confused by the same issue. I went to comment and saw that you beat me to it. Perhaps we could conclude that a ratio of under 10 is a strong sign to buy, and a ratio over 21 is a strong sign to rent, and the “toss-up” range is WAY bigger than expected? ;)

    • jlcollinsnh
      Posted April 10, 2014 at 2:59 pm | Permalink

      Hi MDM & Brovan…

      Your points are well taken and they are the reason I ended that Post Script with this:

      “So maybe these are not much help. More useful, I think, is to look at actual numbers for a given situation as we did above.”

  27. Heywood
    Posted March 21, 2014 at 2:53 pm | Permalink

    There is no example where the “$6000 positive cash flow in house”
    is invested in VGSXL or RAI.
    The “$6000 positive cash flow in house” does not just evaporate.

    • jlcollinsnh
      Posted April 10, 2014 at 3:07 pm | Permalink

      Point well taken, Heywood…

      …that $6000 could be deployed into an investment that would, hopefully, increase in value and/or pay a dividend.

      For those with the discipline to actually do this, adding the calculation into the mix would give a sharper picture.

      Thanks!

  28. Richard
    Posted May 13, 2014 at 2:39 am | Permalink

    I love the article – it’s great how it includes opportunity cost. It’s funny how whenever you talk to people about this subject they seem to assume that owning is better, even though they typically never look at the numbers!

    I have a question about the mortgage interest rate that you mention. You include:
    15,120 estimated interest on our mortgage

    But where did you get this number? If I use a mortgage calculator with 4% interest over 30 years I get a total of $189,735.50 interest. If you average that out over 30 years that’s only $6,324.50 per year.

    Am I missing something?

    Thanks!

    • jlcollinsnh
      Posted May 19, 2014 at 2:49 pm | Permalink

      Hi Richard…

      Great question/observation.

      What you are missing is that interest on a mortgage is paid out as a yearly average. Instead the mortgage payments at the beginning are mostly interest with a bit of principle. Over the years,this shifts as the amount owed is slowly paid down. Toward the end the monthly payments go mostly to principle with a bit to interest.

      In my example I used the interest/principle from the first years as we are comparing own v. rent at the start. In the later years the amount of annual interest would drop and the equity would build as would the opportunity cost of having that equity tied up.

      Hope this makes sense?

      • Richard
        Posted May 20, 2014 at 3:38 am | Permalink

        Yes, that makes sense. Except….it looks to me like the interest in the first year would be $10,475, and then decreasing over time until the last year only $322 would be paid in interest. So, the numbers I’m getting still aren’t as high as your estimated $15,120.

        It seems to me that you would want to consider the number of years you expect to pay the mortgage. Otherwise your estimated interest costs would be higher than what you would actually pay in interest over the course of the mortgage (since it decreases over time).

        I believe I have two other observations that I haven’t seen any comments on.

        First, the opportunity cost would increase over time. As you pay the principal down, you keep increasing the amount of money invested in the house, so your opportunity cost would continually increase. (…giving renting a bit more advantage over time)

        Secondly, over the course of many years you would see your rent increase quite a bit, whereas the mortgage cost is essentially locked in at the start. (…giving owning a house a bit more advantage over time).

        Please correct me if I’m wrong!

        • jlcollinsnh
          Posted May 22, 2014 at 6:15 pm | Permalink

          Hi Richard….

          Well shucks…

          …now you have me wondering just how I arrived at that $15,120 figure in the first place. Usually with a mistake like that I can see how it was made, but after a fair amount of pondering, I’m at a loss, and I’m surprised nobody caught this before. The post has been up over two years!

          In any event, I’ve refigured and updated the numbers:

          Interest on $264,000 at 4% comes to $10,560 on my calculator. Plus I had to refigure the tax savings which now drops to $4765.

          Net result: $2105 premium to live in the house.

          Of course, as I pointed out in Addendum IV:

          I also vastly over estimated the cost of our apartment. Rather than $2000/$24,000 per month/year, the number I used in the post scenarios, the actual rent is $1415 per month, $16,980 for the year.

          Since these numbers are only used as an example to illustrate the concepts, I don’t feel the need to recalculate them with the actual rent in the post. It is the technique that matters and in applying it folk’ll want to use their own numbers anyway.

          Thanks for the fact-checking. Let me know if I got it right this time!

          • Richard
            Posted May 27, 2014 at 9:38 pm | Permalink

            Hi Jim / Mr. Collins!

            Like you, I’m not interested in seeing your numbers recalculated with the actual rent, but I am very interested in the concepts that would lead to results specific to ones situation!

            I’m glad we’re now on the same page regarding the interest payments!

            I’m also curious what your thoughts are on my additional two observations I pointed out in my last reply…..

            I’ve also now run across this, which might be useful to anyone reading this:

            http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

            I haven’t looked at the details, but I like that it includes opportunity costs and you can adjust all the values…

            ~ Richard

          • jlcollinsnh
            Posted May 28, 2014 at 3:34 pm | Permalink

            1. Yes, opportunity cost will increase over the time you own the house. Both as you pay down the debt and if/when the value rises.

            2. Over time, assuming a non-deflationary environment and the absence of rent-control, rent can be expected to increase. But one of the advantages of renting is flexibility and the ease of moving. Should a given apartment, city, state or country become too expensive relocation is simple.

  29. Posted July 19, 2014 at 7:06 am | Permalink

    Personally i think the owning is better if you have a good finance to buy a own house and if not,then renting is better..it’s good describe you the opportunity cost which even i don’t know proper about that.

  30. Ricky
    Posted August 24, 2014 at 10:08 pm | Permalink

    The takeaway is of course that its prudent to run the numbers on any investment decision. All investment decisions have opportunity cost.

    I can see how some are getting the feeling that you are advocating for renting rather than buying. Of course its not always a clear cut as that, as you admit.

    What you REALLY need to know is how small of a house you are willing to downsize to, find comparable rents and home values and run the three different scenarios (staying put, renting smaller home, owning smaller home) against each other. I think that is the main thing that this article leaves out.

    For instance, if you’re now going to rent for $2,000/mo then figure out the actual value of the property you’re looking to rent. Then run the numbers and see if you could find similar properties selling for similar prices and compare owning the cheaper home vs renting the cheaper home.

    For prudent financial planners like yourself, and ones that read this blog, I’d imagine owning is almost always possible and better as long as you don’t want a house well above $150k (depends on area of course, but average). Renting will probably still make more sense in San Francisco, Honolulu, Seattle or New York no matter how you look at it. But for the vast majority of the country, I think there is an avenue to owning that is almost always better.

    So basically, if owning the house yearly + opportunity costs is cheaper than renting yearly then its better to own the house; because, like you say, everyone pays housing costs no matter what.

  31. Roger Van Zanen
    Posted September 11, 2014 at 12:00 am | Permalink

    The lady who thought a clapped out Camaro was worse than a house should check Kelley blue Book. The numbers for the most recent version of Camaro (2010-2015) cheapest price are as follows:
    2015 19550 zero miles Cost per mile – unknown but possibly 5-10 cents
    2014 18800 6700 miles Cost per mile – 11 cents
    2013 18695 11300 miles cost per mile – 8 cents
    2012 16935 38,000 miles Cost per mile – 6.5 cents
    2011 14990 66000 miles Cost per mile – 7 cents
    2010 16400 61,000 miles Cost per mile – 5 cents

    Based on this, I would buy a Camaro before getting a house

  32. Tom
    Posted September 13, 2014 at 10:52 am | Permalink

    Excellent article. This week I had an offer accepted to buy a 2 bed apartment and so stumbling across this article was perfectly timed for me.

    Based on some napkin math, I was pretty sure that buying was the better decision financially but I’ve just spent the whole morning making a spreadsheet based on this article to get an exact figure for my personal situation.

    Buying does indeed work out better for me, even when comparing buying a two bedroom apartment against renting a one bedroom apartment (although I’ve had to guesstimate at maintenance/repair cost per annum as I have never owned property before), although this result is probably because in my area, all rents are increased by inflation annually and so renters perennially pay above the market rate unless they are prepared to move every two or so years, which is a little tedious.

    My calculations have also revealed to me that it will take approximately a year before the reduced cost of buying covers the associated costs incurred making the purchase (legal fees, mortgage booking fees, double paying rent and mortgage for a month or two while we move, other associated moving fees).

    Renting vs. buying always seems like a debate that people respond to emotionally, rather than logically, and we all know that emotions and personal finance is a dangerous combination!

    • jlcollinsnh
      Posted September 13, 2014 at 11:31 am | Permalink

      Hi Tom…

      Great to hear this post was useful to you in your recent purchase decision. My guess is that, knowing how the numbers worked you will always be more comfortable in your new place. It is always great when what you want to do is also the best financial choice.

      But even if renting had been shown to be cheaper, you still could have bought.

      Knowing the the numbers in that case would have allowed you to decide if the extra money was worth it. This was the case when I bought my houses. They certainly cost more than renting, but I could afford them and they were an expensive indulgence I was willing to pay for.

      And, boy howdy, are you right about this subject being an emotional trigger! This post, and those I’ve linked to in it, have gotten me the most hate of anything I’ve ever written. :)

3 Trackbacks

  • By Why Did We Buy Our House? - Frugalwoods on May 18, 2014 at 3:54 pm

    […] and extensively researched, post on the matter is the awesome and amazing JCollinsNH’s “Rent v. Owning Your Home, opportunity cost and running some numbers.” If you haven’t read it, you should. Go ahead, I’ll […]

  • By Just about life | Owning your home on June 26, 2014 at 4:08 am

    […] Run some numbers; it might be evident that it’s not the right thing for you to do, not at this point in your life anyway. […]

  • […] Rent v. Owning Your Home, opportunity cost and running … – Interesting analysis! I always roll my eyes (hopefully people can’t see me) whenever someone repeats the mantra “Your home is your biggest investment!”… […]

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

You may use these HTML tags and attributes <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Subscribe without commenting

Subscribe:
Subscribe to email feed
Email
Subscribe to RSS Feed
RSS